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Strategic Global Intelligence Brief for March 28, 2018

Short Items of Interest—U.S. Economy

GDP Growth Better than Expected

Even just a few days ago, the consensus view was that GDP numbers for the fourth quarter would be better than the earlier predictions, but not as good as they have turned out to be. The final look at the Q4 numbers from 2017 show the economy growing at very nearly 3%. The growth fell just a hair short at 2.9%, but this means the economy lost very little of its momentum as it went into the latter part of the year. That should have an impact on what will be seen in the Q1 numbers for this year. This unexpected growth can be attributed to a more active consumer than had been expected. It was a good holiday season, but it now looks like the party got started even earlier than originally noted and lasted into the new year.

Williams May Be More Controversial than Thought

It seems like he may be, at least from the left of the political spectrum. The objection to John Williams of the San Francisco Fed is not based on his qualifications for taking over the position soon to be vacated by Bill Dudley (NY Fed), but because he is "another white, male economist." The diversity argument has been broached before, but has generally been weakened by the fact that Janet Yellen had become Fed chair and that several of the regional Fed presidents have either been women or minority members. These have included Loretta Mester, Esther George, Raphael Bostic, and Neel Kashkari. There are also some that assert that Williams has missed some economic predictions, but who among us hasn't.

Fiscal Future Looks Rocky

The U.S. has had no issues floating as much debt as it wants or needs to. The demand for U.S. paper is rock solid, or at least it was. However, the U.S. has a future issue that could be difficult to overcome. The tax base is shrinking at the same time that interest rates are coming up. Cutting government programs further has become all but impossible (all that is left is the sacred cows of Medicare, Social Security and Medicaid).

Short Items of Interest—Global Economy

Putin Asserts Britain Did the Poisoning

The Putin assertion seems right out of some badly plotted spy drama. He says the British were actually behind the poisoning of the former Russian agent and his daughter so that they could blame Russia and engage in more sanctions. Never mind that Russia has committed enough transgressions in the last year to be sanctioned far harder than they already have been. This is the kind of appeal to conspiracy nuts that has been tried in the U.S. and Europe and often been handled by the Russians. It seems they are trying to see where else these kinds of fabrications can have an impact. The U.K. is now beyond furious. Many are calling for a complete diplomatic break.

South Africa Getting Attention From Investors Again

The ratings agencies are not yet ready to take South African bonds out of junk status, but the outlooks are far more upbeat. There are many that have been exploring engagement with that economy again. The country seems to have managed to purge itself of Zuma and most of his cronies, so there is hope for a resurgence. Not that Cyril Ramaphosa will have an easy time of it, but at least the worst of the worst are in retreat. This remains the strongest potential player on the continent if it can just get out of its own way.

Fragile Start to Italian Coalition Talks

It seems the easy part was for the two outside parties to win support from a frustrated Italian electorate. Now comes trying to govern. That is a whole other challenge. The two leaders do not much trust or like each other; both think they should be the next prime minister. Matteo Salvini is the head of the Northern League and has made immigration his key platform, while The Five Star Movement is more economically populist in orientation. It is led by the ambitious Luigi di Maio. They know they have no choice but to work with each other, but that has not made the talks any simpler.

Can OPEC and Russia Change the Oil Dynamic?

Over the last decade, the oil world has been changed by the U.S. as the oil shale revolution is in full swing. From a country that needed to import 65% of the crude it needed, the U.S. has become a major oil exporter and the largest producer of oil in the world. This is not a shift that has been welcomed by the likes of OPEC and Russia. They have been mumbling about a strategy that would alter this dynamic. What would that look like and can they pull it off?

Analysis: Last year, the Russians and the leaders of OPEC (Saudi Arabia mostly) agreed to significant reductions in oil output as a means by which to prop up the crashing price of crude. It was in the 30 dollar a barrel range and looked to fall even further. The decision has resulted in higher priced oil, but the market share for OPEC and Russia didn't change much. The U.S. was likely the recipient of the most largesse given the less expensive way we produce oil now. Today, the Russians and OPEC want to consider extending this deal for at least 20 years. The assumption is that oil prices would rise on the news and stay high. That may be correct, but it depends on what the U.S. does. If the price per barrel jumps to $80 or $90, or higher, the U.S. oil sector will see another boom period and will be able to match anything the others cut.

It is all going to come down to whether there is a real "peak demand" situation. If the U.S. produces more oil because the others aren't, will there be demand for it or will reduced demand put a limit on the per barrel price? The gamble for OPEC and Russia is that demand will slacken and the U.S. will not be able to gobble up market share. If demand holds and the U.S. can supply it, the Russians and OPEC may lose big chunks of their market on a permanent basis. The U.S. consumer will be in the driver's seat, and quite literally as their demand will be the key.

Ethiopia Set to Elect Reformer

For the better part of the last four years, the Ethiopian government has been trying to quell demonstrations that have all but paralyzed the nation at times. The ruling coalition has alternated between trying to appease the demonstrators to cracking down hard on them. Nothing has changed the dynamic. It now seems the choice has been made to put one of the youngest leaders in place. Abiy Ahmed from the Oromo People's Democratic Organization is the new president. He will have his hands full from the very start although he has widespread support from the other three parties that are part of the ruling group.

Analysis: Ethiopia has problems that range from dealing with ethnic tension to famine to hostility on most of its borders. One of the country's assets is also one of its greatest threats. It is hoped that Ahmed can trend towards the former. The country has a very widespread and educated diaspora that remains tied to the country and willing to engage under the right circumstances. On the other hand, they fled the nation for a reason and will not give up the personal gains they have made to a fractured and repressive regime. Ahmed has been consistent in his advocacy of making peace with the protesters and has stated that Ethiopia has to find a way to reduce the money spent on national defense.

Who Has the Leverage?

Should China and the U.S. really go after one another on trade? Who has the leverage and who is likely to be more at a disadvantage? More importantly, who is likely to blink first? In the great scheme of things, the country with the deficit is in a better position to "win" a trade war than the country with a trade surplus. This is due to the impact these conditions have on the overall economy. The surplus county relies on exports to increase the GDP and to provide the impetus for growth. Without it, the country slows down and is faced with all the attendant problems this creates—unemployment, reduced revenue and so on. The deficit country sees imports as detracting from growth as these are products and services that are substituting for those that can be provided domestically. The level of unemployment would be reduced by and large, but that does come at a cost to the consumer. The reduction of imports means that everything on offer to the consumer costs more and therefore people buy less. In more extreme situations, this feeds runaway inflation, which can be very damaging as well. For the deficit country to "win," there has to be some very astute strategy in place to maximize the advantages and reduce the impact of the downside. At the moment, it doesn't appear the U.S. has that in place.

Analysis: It is important to understand what begets what in terms of trade and economics. The link that economists have long established between trade and the greater economy is the balance between national savings and national investment. The gap between the two is what propels trade rather than the other way around. Put simply, a deficit nation like the U.S. needs to save more and spend less. The more the emphasis is on saving, the less consumption there is and the less demand for imports. The U.S. has long been a spending-oriented country and has always tried to boost that activity. There is a reason that consumers are 80% of the U.S. GDP. The latest policy push has been to get even more spending in place. That makes the trade balance even worse. The simple fact is that demand in the U.S. outstrips the ability to ramp up production. There are few ways to bring that back into balance and most are unpleasant. Over-demand creates shortages, which in turn creates inflation. The alternative is to bring even more in from outside the U.S. to meet that demand. It was only a few years ago that U.S. imports were down and the trade balance was improving month by month. It was the result of the recession as the consumer was not in a position to consume as they had before—regardless of whether the good or service was imported or domestically produced.

Another strategy that could be employed would consist of some kind of capital controls that make it harder for the Chinese and others to buy U.S. debt. This is how surplus countries go about financing the deficit countries. This expansion of Chinese acquisition of U.S. securities worries people more than it should. It seems the U.S. is ceding financial power to the country that is buying our debt, but these sums are large enough that it is really just the opposite. The surplus country has to do something with that money. Therefore, they have to invest it. It is not remotely in their best interests to cause the value of their investment to fall. Meanwhile, the deficit country needs that surplus country to underwrite that debt so that it doesn't need to resort to the other options such as deep spending cuts or aggressive revenue increases.

Latest Wrinkles on Trade

Unfortunately, we all tend to like labeling things and categorizing them—helps us make sense of a complex world. We want simple despite the fact that nothing ever is. Trade relations are probably the most complex set of interactions a country can be engaged in because there will never be a clear winner, or a clear loser for that matter. It is a trade—something is to be given up in return for something else. That which is given up has value—just not as much as the thing acquired—at least at that precise moment. The Trump mantra on trade is that other countries always take advantage of the U.S. and it always gets the short end of the stick. But the statements from the other nations always say the same thing—the U.S. gets all it wants and they get nothing. Of course, much of this hyperbole is designed for domestic consumption. If you elect to import something or give access to your market, there will be domestic interests that will be less than happy with that additional competition. Better to submit the argument that you were fleeced than to assert they are just not as important to your economy as some other sector.

Analysis: The assertion is that the U.S. has become highly protectionist and no longer supports free trade. The rhetoric from the White House and Congress would certainly reinforce that opinion, but on closer examination, it appears that much less change has really taken place. The U.S. was once a highly vocal advocate of trade. That was often designed to pressure other countries into trade deals that were likely of more interest to the U.S. than to them. These nations did not want to be labeled protectionist or obstructionist. The U.S. has wanted to pursue a policy that gives its service sector free access. This is the center of the U.S. economy and these are the new and vibrant industries that are generally less developed in other countries. The U.S. wants access for its finance sector, insurance and telecoms in addition to high tech and health care and a whole host of sectors related to marketing and advertising and the like. The countries the U.S. deals with would like to develop those sectors as well, but it takes a significant investment in appropriate infrastructure. The U.S. has a massive advantage here and wants to maintain it. In order to get that access, the U.S. has been willing to trade—mostly in the manufacturing and agricultural sectors. It is a good trade-off from a GDP growth point of view, but not so good for those people who work in the factories and farms that face intense competition from overseas.

The Trump campaign focused on this segment of the U.S. population and it worked very well. These are people who are definitely scared for their future and that of their children. They worry that their entire way of life will be challenged, so they resist. Trade with other countries was identified as the convenient enemy despite the preponderance of evidence showing that this has not really been the issue. If there has been one "culprit" behind the erosion of manufacturing jobs, it has been technology. The U.S. is as productive as it has ever been as a world manufacturer, but with some 20 million fewer workers than was the case just a decade or so ago. This is not due to increased off-shoring or increased imports. In fact, we import less in the way of manufactured goods than we used to, but we import less from other nations and more from China. We have robots doing the work that people once did.

The last few weeks of rhetoric would give the impression the U.S. has turned its back on trade and become far tougher. The reality is that universal tariffs on steel swiftly became restrictions on steel from China and Russia. The threats against South Korean exports vanished as a new trade deal was signed. Even the big attack on China was mostly bombast as negotiations are underway that focus on getting U.S. business better access to China. There even seems to be some willingness in Beijing to see this happen. Was all this just politics and appealing to the Trump base? Is there method to the madness as far as exacting concessions from trade partners? Has the U.S. been too accommodating in the past? The answer is likely yes to all three questions. It is, after all, a complex topic.

Getting to the End!

I have not wanted to turn this column into a running commentary on my health, but these days, the process has been dominating most of my time. Normally, I would have had all kinds of pithy comments on the vagaries of travel, but I have been grounded for the most part. The few trips I managed took their toll. I have been doing 33 rounds of radiation and six rounds of chemo. These really gobble up time. The good news is the last chemo was Monday and the last radiation will be Thursday. After that, I am expected to make a slow and laborious recovery—probably another month of dealing with all the side effects, but at least no more additional damage.

The process is an interesting one and the reverse of normal maladies. We all know the usual pattern—get sick and feel better every day after that as the treatment progresses. With cancer, the treatment is the malady. To kill this disease requires trying to come close to killing the patient. Not that my version ever got that serious, but chemo is basically flooding the body with poison that kills the fast-growing cancer first, but also attacks everything else. Radiation is quite literally scorched earth tactics—burning away everything that might promote or host the cancer cells. My biggest fights have been over pain control and malnutrition. Not that I am a shadow of my former self, but I have not seen a scale register less than 200 pounds in decades. Losing 35 pounds this way is not my recommendation.

I have to express my gratitude towards so many friends and colleagues who have remained patient through all this. I have not been as productive as I need to be, have had to let people down and generally behave selfishly at times. I will have a chance to make this up to people in weeks and months to come, but I will never forget all the kindness I have been shown. I am looking forward to commenting on flights and hotels again—really!

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Sunday, 15 September 2019